What Determines the Content of Corporate Governance Codes?

Carsten:
I am an Associate Professor of Law at the London School of Economics
and Political Science who conducted research on corporate governance,
securities regulation, and law and economics and prepared reports on
corporate governance and financial regulation for the European
Commission and the European Parliament. One strand of my research on
corporate law and securities regulation deals with the legal and
nonlegal determinants of regulatory reform, the international diffusion
of legal innovations, and the interrelationship between the regulatory
environment and economic variables. I generally use a comparative and
interdisciplinary approach. My current projects include analyzing the
European Union (EU) harmonization program in company law and capital
markets regulation to facilitate discussions about how regulatory
authority should be allocated between the EU and the Member States to
promote integrated markets and ensure efficient regulatory outcomes. I
am also working on a comprehensive treatise on comparative company law
that examines in-depth some of the main legal traditions of the world,
compares the regulatory strategies employed, and explains the observed
differences in historical perspective.

Caroline: What got you interested in the origins of corporate governance codes?

Carsten:
Having worked on corporate governance for some time and teaching at
LSE, I saw that corporate governance codes are very influential in
creating what is seen as best practice for boards and others involved in
corporate governance. It therefore seemed to me important to analyze
how such codes are developed and lead to the dissemination of new
techniques in regulating corporate governance in a changing political,
economic, and legal environment.

Caroline: How did you go about your research?

Carsten: I analyzed 106 corporate governance codes of 23 European countries and tried to classify them according to:

the
extent to which the drafting committee was dominated by representatives
of the investment community, issuers' representatives, public
regulators, or others. It is important to note that most codes are not
legislative initiatives but private initiatives for example, by stock
exchanges and industry bodies; and

the type of legal framework used by the relevant country.

I then looked at the provisions of the codes and analyzed them according to:

how prescriptive they are, and

whether they strengthen the position of outside investors

… in relation to a number of issues including:

independence,

board and board committee composition, and

separation of the roles of CEO and chairman of the board.

Caroline: What did you find?

Carsten:
Certainly, some codes are more onerous and more prescriptive than
others. For example, some specify the number of nonexecutive versus
executive directors (senior managers) that should be on the board,
whereas other codes use terms such as sufficient nonexecutives, leaving
wide room for interpretation by individual boards. Some codes are clear
that the roles of chair and CEO should be separated and, for example,
specify a “cooling-off period” before a retiring CEO can become a chair.
Others are much less prescriptive on such separation. In some codes
what represents “independence” is spelled out (for example, the United
Kingdom's code gives a list of criteria2). In other codes what is meant by the term is left much vaguer.

I
had also thought that it was likely that we would find that the content
of codes was heavily influenced by the composition of the committees
that produced them. For example, I thought we might find that codes
produced by committees with significant representation from investors
would be more onerous and prescriptive than the content of codes
produced by other groups. In fact, I found no correlation between
composition of code-authoring committees and the code content.

However,
I did find clear differences between different countries when grouped
by legal families. By “legal families” I mean groups of countries that
operate in accordance with different legal frameworks such as English
Common Law, the Civil and Commercial Codes of France, or the German or
Scandinavian systems. I also found differences related to the nature of
typical corporate ownership—concentrated or dispersed, relative
proportions of foreign and institutional investors.

Furthermore, I
found that regulatory reform in corporate governance is significantly
influenced by changes to international benchmark models of good
governance.

It is remarkable that, although the probability of one
country adopting a particular regulatory mechanism in a corporate
governance code increases the more other countries have adopted a
similar term, the amount of legal variance between European countries'
corporate governance regimes has not significantly diminished. So in
spite of much cross-border legal learning, the convergence of corporate
governance regimes, defined formally as the lower variance of legal
variables over time, has not yet occurred in Europe.

Caroline: How influential are corporate governance codes on practice?

Carsten:
My research did not cover this, but certainly the number of codes is
increasing around the world. The European Corporate Governance
Institute's (ECGI) website3
makes available the full texts of corporate governance codes,
principles of corporate governance, and corporate governance reforms
both in Europe and elsewhere.

The United States does not have one
major recognized corporate governance code, although they do have the
New York Stock Exchange listing rules. Generally, the United States
operates in a more rules-based manner when it comes to corporate
governance and accounting. Codes tend to be more influential in other
parts of the world where guidance based on principles is the preferred
approach.

There is evidence that the compliance rate with the UK
Corporate Governance code is very good when compared with that of other
countries. We do know, from an annual survey of compliance by FTSE 350
companies carried out by Grant Thornton,4
that, in 2014, 94 percent of companies complied with all but one or two
of the Code's 54 provisions, while 61 percent reported full compliance
with the Code—an increase of 4 percent over 2013.

On the other
hand, the relationship between high rates of compliance with corporate
governance codes and firm performance is still unclear. And that link is
never going to be easy to identify given the difficulty of separating
out all the other factors that influence performance. However, there is
some evidence showing an association between compliance with corporate
governance codes and the proper functioning of certain corporate
governance mechanisms within firms, such as compliance with disclosure
regulation.

Caroline: Do you have any opinions or questions about the validity of the determinants of corporate governance codes that you found?

Carsten:
It is heartening to find that, holding all other factors constant,
group politics—one group trying to create corporate governance norms to
advantage their interests over others' interests—is not what seems to be
happening.

What does seem to be happening, holding all other
factors constant, is that the more countries that have adopted a
particular code provision, the more likely that other countries will
adopt the same provision when introducing or revising their codes.
Therefore, what seems to be important to authoring committees is what
are the common perceptions in the wider world beyond themselves about
what good corporate governance is and isn't.

Corporate governance
codes therefore seem to be seen as important signals of best practice.
Corporations in every country want to send out signals that they are
well governed—good places to do business—and having corporate governance
codes that measure up to those of other respected jurisdictions is one
way of doing this.

One example of this in action is that the whole
idea of “independent directors,” which was originally proposed by the
Cadbury Committee,5
which created the very first national corporate governance code in
1992, now appears in nearly all codes. Another example is that one often
finds code provisions that seem to have been copied from another code
almost word for word.

It is as if everyone is measuring themselves
against an internationally emerging standard—code authors think they
need to do the same as everybody else in order not to be seen as
substandard. It is a different question whether the drafting committee
believes what they are calling for improves performance or is well
aligned with the domestic legal and/or economic environment, but they
seem to feel obliged to meet what is seen as a common standard.

This
could be used to say that good corporate governance is more a matter of
“groupthink” than anything else, but I will leave that for readers of Board Leadership and others to discuss.